Theory Base of Accounting - NCERT

1 23 Theory Base of AccountingLEARNING OBJECTIVESA fter studying this chapter,you will be able to: identify the need fortheory base of acco-unting; explain the nature ofGenerally AcceptedAccounting Principles(GAAP); state the meaning andpurpose of the basicaccounting concepts; list the accountingstandards issued byInstitute of CharteredAccountants of india ; describe the systemsof Accounting ; and describe the basis discussed in the previous chapter, accountingis concerned with the recording, classifying andsummarising of financial transactions and eventsand interpreting the results thereof. It aims atproviding information about the financialperformance of a firm to its various users such asowners, managers employees, investors, creditors,suppliers of goods and services and tax authoritiesand help them in taking important decisions.

2 Theinvestors, for example, may be interested in knowingthe extent of profit or loss earned by the firm duringa given period and compare it with the performanceof other similar enterprises. The suppliers of credit,say a banker, may, in addition, be interested inliquidity position of the enterprise. All these peoplelook forward to Accounting for appropriate, usefuland reliable making the Accounting informationmeaningful to its internal and external users, it isimportant that such information is reliable as wellas comparable. The comparability of information isrequired both to make inter-firm comparisons, see how a firm has performed as compared tothe other firms, as well as to make inter-periodcomparison, how it has performed as comparedto the previous years.

3 This becomes possible only ifthe information provided by the financial statementsis based on consistent Accounting policies, principlesand practices. Such consistency is requiredthroughout the process of identifying the events andTheory Base of Accounting22022-2324 Accountancytransactions to be accounted for, measuring them, communicating them in thebook of accounts, summarising the results thereof and reporting them to theinterested parties. This calls for developing a proper Theory base of importance of Accounting Theory need not be over-emphasised as nodiscipline can develop without a sound theoretical base. The Theory base ofaccounting consists of principles, concepts, rules and guidelines developedover a period of time to bring uniformity and consistency to the process ofaccounting and enhance its utility to different users of Accounting from these, the institute of Chartered accountants of india , (ICAI), whichis the regulatory body for standardisation of Accounting policies in the countryhas issued Accounting Standards which are expected to be uniformly adheredto, in order to bring consistency in the Accounting practices.

4 These are discussedin the sections to Accepted Accounting PrinciplesIn order to maintain uniformity and consistency in Accounting records, certainrules or principles have been developed which are generally accepted by theaccounting profession. These rules are called by different names such asprinciples, concepts, conventions, postulates, assumptions and term principle has been defined by AICPA as A general law or ruleadopted or professed as a guide to action, a settled ground or basis of conductor practice . The word generally means in a general manner , , pertaining tomany persons or cases or occasions. Thus, Generally Accepted AccountingPrinciples (GAAP) refers to the rules or guidelines adopted for recording andreporting of business transactions, in order to bring uniformity in thepreparation and the presentation of financial statements.

5 For example, one ofthe important rule is to record all transactions on the basis of historical cost,which is verifiable from the documents such as cash receipt for the moneypaid. This brings in objectivity in the process of recording and makes theaccounting statements more acceptable to various Generally Accepted Accounting Principles have evolved over a long periodof time on the basis of past experiences, usages or customs, statements byindividuals and professional bodies and regulations by government agenciesand have general acceptability among most Accounting professionals. However,the principles of Accounting are not static in nature. These are constantlyinfluenced by changes in the legal, social and economic environment as well asthe needs of the principles are also referred as concepts and conventions.

6 The termconcept refers to the necessary assumptions and ideas which are fundamentalto Accounting practice, and the term convention connotes customs or traditionsas a guide to the preparation of Accounting statements. In practice, the samerules or guidelines have been described by one author as a concept, by another2022-2325 Theory Base of Accountingas a postulate and still by another as convention. This at times becomes confusingto the learners. Instead of going into the semantics of these terms, it is importantto concentrate on the practicability of their usage. From the practicability viewpoint, it is observed that the various terms such as principles, postulates,conventions, modifying principles, assumptions, etc.

7 Have been used inter-changeably and are referred to as Basic Accounting Concepts in the Accounting ConceptsThe basic Accounting concepts are referred to as the fundamental ideas or basicassumptions underlying the Theory and practice of financial Accounting andare broad working rules for all Accounting activities and developed by theaccounting profession. The important concepts have been listed as below: Business entity; Money measurement; Going concern; Accounting period; Cost Dual aspect (or Duality); Revenue recognition (Realisation); Matching; Full disclosure; Consistency; Conservatism (Prudence); Materiality; Entity ConceptBusiness Entity ConceptBusiness Entity ConceptBusiness Entity ConceptBusiness Entity ConceptThe concept of business entity assumes that business has a distinct and separateentity from its owners.

8 It means that for the purposes of Accounting , the businessand its owners are to be treated as two separate entities. Keeping this in view,when a person brings in some money as capital into his business, in accountingrecords, it is treated as liability of the business to the owner. Here, one separateentity (owner) is assumed to be giving money to another distinct entity (businessunit). Similarly, when the owner withdraws any money from the business for hispersonal expenses(drawings), it is treated as reduction of the owner s capitaland consequently a reduction in the liabilities of the Accounting records are made in the book of accounts from the point of viewof the business unit and not that of the owner. The personal assets and liabilitiesof the owner are, therefore, not considered while recording and reporting theassets and liabilities of the business.

9 Similarly, personal transactions of the ownerare not recorded in the books of the business, unless it involves inflow or outflowof business Measurement ConceptMoney Measurement ConceptMoney Measurement ConceptMoney Measurement ConceptMoney Measurement ConceptThe concept of money measurement states that only those transactions andhappenings in an organisation which can be expressed in terms of moneysuch as sale of goods or payment of expenses or receipt of income, etc., are to berecorded in the book of accounts. All such transactions or happenings which2022-2326 Accountancycan not be expressed in monetary terms, for example, the appointment of amanager, capabilities of its human resources or creativity of its researchdepartment or image of the organisation among people in general do not find aplace in the Accounting records of a important aspect of the concept of money measurement is that therecords of the transactions are to be kept not in the physical units but in themonetary unit.

10 For example, an organisation may, on a particular day, have afactory on a piece of land measuring 2 acres, office building containing 10 rooms,30 personal computers, 30 office chairs and tables, a bank balance of `5 lakh,raw material weighing 20-tons, and 100 cartons of finished goods. These assetsare expressed in different units, so can not be added to give any meaningfulinformation about the total worth of business. For Accounting purposes,therefore, these are shown in money terms and recorded in rupees and paise. Inthis case, the cost of factory land may be say ` 2 crore; office building ` 1 crore;computers `15 lakh; office chairs and tables ` 2 lakh; raw material ` 33 lakhand finished goods ` 4 lakh. Thus, the total assets of the enterprise are valued at` 3 crore and 59 lakh.